Direct taxes

Personal income tax comes to Narendra Modi govt’s rescue as corporate tax falls

Earlier this week, the government released some interesting data on direct taxes which essentially are composed of corporate taxes, personal income tax. They also include tax collected through the income tax amnesty schemes launched by the governments over the years.

How have these taxes done over the years? Has the Narendra Modi government managed to collect more direct taxes than the earlier government’s (as is often said)? The recently released data provides the answers.

Take a look at Figure 1. It basically plots the direct taxes to the GDP ratio over the years.

Figure 1:

Tax to GDP

Source: http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

 

What does Figure 1 tell us? It tells us very clearly that the direct taxes collection as a proportion of the GDP, has remained flat over the last few years, including the three years of the Modi government. It also tells us very clearly that whenever a politician talks about the collection of direct taxes (or for that matter any other tax) going up, it should be in the context of the size of the economy (i.e. the GDP).

If that is not the case, then he or she is clearly bluffing or does not understand how taxes are reported. As I said earlier, the direct taxes are comprised of personal income tax, corporate tax and other direct taxes. First and foremost, let’s take a look at how things look if we ignore the other direct taxes. This is important for the year 2016-2017, when the government managed to collect a significant amount of tax, through two income-tax amnesty schemes, one launched before demonetisation, and one after it.

Figure 2:

Net direct tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Unlike Figure 1, which curves up at the end, Figure 2 is more flattish, once we adjust for the other direct tax. This matters in a year like 2016-2017, when the government collected Rs 15,624 crore as other direct tax, much of which was collected from income tax amnesty schemes. Once adjusted for this, the direct taxes to GDP ratio in 2016-2017 falls to 5.49 percent. In 2015-2016, it was at 5.46 percent of the GDP. This is much lower than the 6.30 percent achieved in 2007-2008. Hence, the direct taxes to GDP ratio has fallen over the years.

It is important to take a look at how does the situation look for corporate tax and personal income tax, as a proportion of the GDP, the two most important constituents of direct taxes. Let’s take a look at Figure 3, which plots the corporate income tax as a proportion of GDP.

Figure 3:

Corp tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 3 tell us very clearly that corporate income tax to GDP ratio has been falling over the years. It has fallen from a peak of 3.88 percent of the GDP in 2007-2008 to 3.19 percent in 2016-2017. One reason for this has been the slow growth in corporate earnings over the last few years. Finance Minister Arun Jaitley has talked about lowering corporate income tax rates, but that hasn’t really happened. Whether lower taxes lead to higher collections remains to be seen.

Now let’s take a look at Figure 4, which plots to the personal income tax to GDP ratio.

Figure 4:

personal tax

Source: Author Calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 4 makes for an interesting reading. While, personal income tax to GDP ratio like the corporate tax to GDP ratio also fell, it has managed to recover over the years. Basically, the loss of income tax from the corporates has been covered by getting individuals to pay more income tax, on the whole. One reason for this lies in the fact that the number of individual assessees have risen at a much faster rate over the years, than the number of corporate assessees. And this jump has basically ensured that the tax collections of the Narendra Modi government have continued to remain flat. They would have fallen otherwise.

The column originally appeared on Firstpost on December 21, 2017.

Here’s One Thing Modi Govt Should Do in Its Remaining Budgets

narendra_modi

The annual budget of the Narendra Modi government will be presented by the finance minister Arun Jaitley on February 29, the last day of this month.

Given this, it is a season where everyone has been advising Jaitley on how to go about the entire thing. Some economists have said that the government should increase the public investment, in order to get the economy growing at a faster pace. Others have said that it is important that the government maintain the fiscal deficit target that it has set for itself and not spend more in the process of increasing public investment. Fiscal deficit is the difference between what a government earns and what it spends.

Regular readers of the Diary will know that I am in the government trying to maintain its fiscal deficit camp. Having said that I am not against the government ramping up public investment as long as it can find the money to do so without increasing the fiscal deficit and borrowing more in the process.

As World Bank chief economist Kaushik Basu writes in his new book An Economist in the Real World—The Art of Policymaking in India: “A fiscal stimulus is like an antibiotic. It is very effective when used for a short period of time. But if used repeatedly and over long stretches of time, the side effects tend to outstrip the benefits. In India’s case a large deficit is likely to fuel the inflation rate.”

Given this, it is very important as to how the government goes about increasing public investment. As Basu writes: “Choices have to be made very carefully. The first task to which more effort needs to be directed is raising tax revenue.”

Take a look at the accompanying table. Between 2010-11 and this financial year, the taxes as a proportion of gross domestic product have more or less been similar, and have varied within a narrow range. Interestingly, the taxes as a proportion of GDP have fallen since 2007-08.

 

YearDirect taxes as a % of GDPIndirect taxes as a % of GDPTaxes as a % of GDP
2004-054.15.269.36
2005-064.475.49.87
2006-075.365.6210.98
2007-086.265.611.86
2008-095.934.7910.72
2009-105.833.769.59
2010-115.724.410.12
2011-125.594.4310.02
2012-135.594.7510.34
2013-145.634.3710
2014-155.634.319.94
2015-165.664.5810.24
Source: Reserve Bank of IndiaAverage10.25

 

One possible explanation for this lies in the fact that both the stock market as well as real estate prices rallied between 2002-03 and 2007-08. This meant that investors would have made a lot of capital gains, on which they would have paid capital gains tax. This would have pushed the total amount of income tax collected by the government.

In 2001-02, the direct taxes amounted to around 2.94% of the GDP. By 2007-08, they had jumped up to 6.26% of the GDP. Another possible explanation for this lies in the fact that the salaried class got very good increments during the period. Also, the wealth effect was at play as well. With stock prices and real estate prices going up, people felt wealthy and in the process indulged in greater consumption. This led to the collection of higher indirect taxes. The collection of indirect taxes fell dramatically after 2007-08. In 2009-10, indirect taxes collected were at 3.76% of the GDP.

Since 2010-11, the collection of direct as well as indirect taxes as a proportion of GDP has been more or less flat. What this means is that the same set of people are essentially financing the Indian government and there seems to have been no effort made to expand the tax base. As Basu puts it: “Not only is India’s tax-to-GDP ratio low, it went down over the last seven years. Global comparison suggests that India can do much better.”

How does India fair in comparison to other countries when it comes to the tax to GDP ratio? A study titled Tax Revenue Mobilisation In Developing Countries: Issues and Challenges points out: “In comparative perspective, developing countries raise substantially less revenue than advanced economies. The ratio of tax to GDP in low-income countries is between 10% and 20% whereas for OECD economies [or developed economies] it is in the range of 30- 40%.”

What this clearly tells us is that India is at the lower end of the spectrum when it comes to collecting taxes and hence, there is tremendous scope to improve. As Basu puts it: “India should aim to reach a tax revenue-to-GDP ratio of 15 percent within two or three years, and then set an even higher target of, for instance, 20 percent over the medium term.”

This does not mean that the government has to raise tax rates. As Basu writes: “This can be done almost entirely through plugging of loopholes and prevention of tax evasion, and the implementation of a more rational tax code, without having to raise taxes.”

Interestingly, along with the budget every year, the government releases the statement of revenue foregone. As the statement released with the last budget pointed out: “The aggregate revenue impact of incentives available in respect of direct and indirect taxes (levied by the Central Government) is Rs 5,49,984.1 crore for 2013-14 and is projected to be Rs 5,89,285.2 crore for 2014-15.” The point being if the tax laws did not have a significant number of exemptions, the government would have collected more tax.

As the statement further points out: “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures.”

Hence, there is a lot to gain for the government if it goes about plugging these loopholes. But then that would mean side-lining corporate lobbies and big business, which finance political parties. Can the Modi government afford to do that?

On that your guess is as good as mine!

The column was originally published in Vivek Kaul’s Diary on February 25, 2016

 

How India’s informal black economy severely hurts the government

rupeeThe annual report of the ministry of finance points out that the total number of income tax assessees as on October 30, 2014, had stood at 4.79 crore.
The number had stood at 4.7 crore as on March 31, 2014. As on March 31, 2011, the number had stood at 4.08 crore. This means that between March 2011 and March 2014, the number of assessees filing their income tax returns went up by a minuscule 4.8 per year.
In fact, the method of measuring the total number of income tax assessees was revised in March 2014 and this revision has pushed up the number of assessees considerably. As per the earlier method, the total number of assessees as on March 31, 2011, had stood at 3.55 crore. The new method pushed up the total number of assessees by more than 50 lakh, as of end March 2011. This is not a reason to worry given that the new methodology is more reliable and accurate.
Nevertheless, despite this revision, on the whole, the total number of income tax assessees in India remains very small. In comparison, nearly 45% of American population files income tax return. What this means in an Indian context is that India has a huge informal economy which as Taimur Baig of Deutsche Bank Research puts in a recent research note, operates “outside the lens of formal observation, oversight, or analysis.”
“India’s statistics commission suggests that half the gross national product is accounted for by the informal economy…Numerous businesses are unincorporated, transactions involving huge quantities proceed daily on a cash basis, most people and businesses do not file for taxes, making a sizeable chunk of the economy unregulated and unsupervised…The government finds it hard to widen the tax net, ending up overburdening the formal sector,” writes Baig.
The government’s inability to widen the tax net as Baig writes and as data in the annual report of the ministry of finance suggests, has led to a situation where the government has to regularly slash expenditure towards the last few months of the financial year. Take the case of the last financial year 2014-2015, the total expenditure of the government when the budget was presented in July 2014 had stood at Rs 17,94,892 crore. By the time the next budget was presented in February 2015, the total expenditure had been slashed by 6.3% to Rs 16,81,158 crore. This is a trend that has played out in each of the last three financial years.
Typically when the government has to cut down on its expenditure, it is the plan expenditure which faces the severest cut. Take the case in 2014-2015, the plan expenditure at the beginning of the year had been set at Rs 4,53,503 crore. It finally came in at 19.1% lower or Rs 3,66,884 crore As I have often pointed out in the past, plan expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure on the other hand is an outcome of plan expenditure. For example, the government constructs a highway using money categorised as a plan expenditure. But the money that goes towards the maintenance of that highway is non-plan expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. Given the regularity of the non-plan expenditure the asset creating plan-expenditure gets slashed. And that is clearly not a good thing.
This largely happens due the inability of the government to grow its tax base. Another disturbing trend that has emerged over the last few years is the growing dependence of the government on revenues from indirect taxes like customs duty, excise duty and service tax.
Data from the Reserve Bank of India shows that in 1990-1991, direct taxes (income tax, corporation tax and wealth tax, which has been done away with from this financial year) formed 16.06% of the total taxes collected by the government. Indirect taxes formed 83.94%.
In 1991-1992, the year economic reforms were first initiated, direct taxes jumped to 20.2% whereas indirect taxes fell to 79.8%. Since then, direct taxes maintained their upward move and by 2009-2010 formed 59.5% of the total taxes. The share of indirect taxes had fallen to 40.5%.
The trend has been reversed since then and in 2013-2014, the share of direct taxes had fallen to 53.9%, whereas indirect taxes had jumped to 46.1%.
This is a clearly worrying trend simply because indirect taxes are regressive. A regressive tax is essentially a tax which is applied uniformly on everyone and given that it means that individuals with lower-incomes are hit harder.
That isn’t the case with direct taxes like income tax where the marginal rate of taxation goes up as the taxable income goes up. Given this, it is important that the government focuses on increasing the total number of people paying direct taxes.
As Baig of Deutsche Bank Research points out: “Tax authorities in recent decades have handed out simplified procedures to file for taxes and register businesses, although the results have not been encouraging. Previously untaxed parts of the economy, especially in the services sector, have been brought into the tax net, but the fact that tax yield has not improved suggests room for improvement.”
Also, the government seems to be focussed on recovering the black money that has already been accumulated. Some focus on widening the tax base and ensuring that the black money that will be generated in the future comes down will not do it any harm.

The column appeared originally on The Daily Reckoning, on May 27, 2015